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Granite City Food & Brewery 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-3.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 27, 2011

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 000-29643

 

GRANITE CITY FOOD & BREWERY LTD.

(Exact Name of Registrant as Specified in Its Charter)

 

Minnesota

 

41-1883639

(State or Other Jurisdiction

 

(I.R.S. Employer

of Incorporation or Organization)

 

Identification No.)

 

5402 Parkdale Drive, Suite 101

Minneapolis, Minnesota 55416

(952) 215-0660

(Address of Principal Executive Offices and Issuer’s

Telephone Number, including Area Code)

 

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company x

(Do not check if smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of November 7, 2011, the issuer had outstanding 4,687,582 shares of common stock.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

 

Page

 

 

 

PART I

FINANCIAL INFORMATION

1

 

 

 

ITEM 1

Financial Statements (Unaudited)

1

 

 

 

 

Condensed Consolidated Balance Sheets as of September 27, 2011 and December 28, 2010

1

 

 

 

 

Condensed Consolidated Statements of Operations for the Thirteen and Thirty-nine Weeks ended September 27, 2011 and September 28, 2010

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Thirty-nine Weeks ended September 27, 2011 and September 28, 2010

3

 

 

 

 

Notes to Condensed Consolidated Financial Statements

4

 

 

 

ITEM 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

 

 

 

ITEM 3

Quantitative and Qualitative Disclosures about Market Risk

32

 

 

 

ITEM 4

Controls and Procedures

32

 

 

 

PART II

OTHER INFORMATION

33

 

 

 

ITEM 1

Legal Proceedings

33

 

 

 

ITEM 1A

Risk Factors

33

 

 

 

ITEM 2

Unregistered Sales of Equity Securities and Use of Proceeds

33

 

 

 

ITEM 3

Defaults upon Senior Securities

33

 

 

 

ITEM 4

(Removed and Reserved)

33

 

 

 

ITEM 5

Other Information

33

 

 

 

ITEM 6

Exhibits

33

 

 

 

SIGNATURES

34

 

 

INDEX TO EXHIBITS

35

 

i



Table of Contents

 

PART I       FINANCIAL INFORMATION

 

ITEM 1  Financial Statements

 

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

 

 

September 27,

 

December 28,

 

 

 

2011

 

2010

 

ASSETS:

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

1,435,333

 

$

3,104,320

 

Inventory

 

991,330

 

896,100

 

Prepaids and other

 

993,530

 

816,607

 

Total current assets

 

3,420,193

 

4,817,027

 

 

 

 

 

 

 

Deferred transaction costs

 

 

108,344

 

Prepaid rent, net of current portion

 

206,287

 

245,904

 

Property and equipment, net

 

49,114,683

 

50,153,176

 

Intangible and other assets

 

1,420,563

 

1,138,610

 

Total assets

 

$

54,161,726

 

$

56,463,061

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY:

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,766,890

 

$

2,513,677

 

Accrued expenses

 

5,184,494

 

6,784,542

 

Accrued exit or disposal activities, current portion

 

 

139,314

 

Deferred rent, current portion

 

450,534

 

1,410,828

 

Deferred gain, current portion

 

30,516

 

51,532

 

Line of credit, current portion

 

68,210

 

 

Long-term debt, current portion

 

693,757

 

1,894,195

 

Capital lease obligations, current portion

 

706,920

 

1,220,049

 

Total current liabilities

 

9,901,321

 

14,014,137

 

 

 

 

 

 

 

Accrued exit or disposal activities, net of current portion

 

 

2,193,904

 

Deferred rent, net of current portion

 

3,671,027

 

4,132,671

 

Deferred gain, net of current portion

 

190,724

 

327,044

 

Line of credit, net of current portion

 

931,790

 

 

Long-term debt, net of current portion

 

7,175,396

 

227,268

 

Capital lease obligations, net of current portion

 

30,059,059

 

32,110,970

 

Total liabilities

 

51,929,317

 

53,005,994

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock, $0.01 par value, 10,000,000 shares authorized; 3,000,000 and 0 shares issued and outstanding at 9/27/11 and 12/28/10, respectively

 

30,000

 

 

Common stock, $0.01 par value, 90,000,000 shares authorized; 4,654,067 and 7,367,895 shares issued and outstanding at 9/27/11 and 12/28/10, respectively

 

46,541

 

73,679

 

Additional paid-in capital

 

73,152,065

 

59,062,891

 

Stock dividends distributable

 

335

 

 

Accumulated deficit

 

(70,996,532

)

(55,679,503

)

Total shareholders’ equity

 

2,232,409

 

3,457,067

 

 

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

54,161,726

 

$

56,463,061

 

 

See notes to condensed consolidated financial statements.

 

1



Table of Contents

 

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Restaurant revenue

 

$

22,945,303

 

$

22,271,547

 

$

70,072,350

 

$

67,729,980

 

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

Food, beverage and retail

 

6,252,503

 

6,163,390

 

19,048,008

 

18,694,615

 

Labor

 

7,803,658

 

7,639,081

 

23,983,390

 

23,203,003

 

Direct restaurant operating

 

3,583,686

 

3,504,658

 

10,410,292

 

9,931,699

 

Occupancy

 

1,858,212

 

1,997,789

 

5,250,643

 

6,399,753

 

Total cost of sales

 

19,498,059

 

19,304,918

 

58,692,333

 

58,229,070

 

 

 

 

 

 

 

 

 

 

 

Pre-opening

 

6,608

 

 

6,608

 

 

General and administrative

 

1,985,543

 

1,588,399

 

5,736,591

 

4,803,441

 

Depreciation and amortization

 

1,458,486

 

1,512,449

 

4,526,246

 

4,469,527

 

Exit or disposal activities

 

17,660

 

374,485

 

(156,900

)

634,876

 

(Gain) loss on disposal of assets

 

36,340

 

17,969

 

(34,619

)

(58,186

)

Operating income (loss)

 

(57,393

)

(526,673

)

1,302,091

 

(348,748

)

 

 

 

 

 

 

 

 

 

 

Interest:

 

 

 

 

 

 

 

 

 

Income

 

20

 

5,968

 

4,197

 

10,151

 

Expense

 

(948,013

)

(936,985

)

(2,824,059

)

(2,590,658

)

Net interest expense

 

(947,993

)

(931,017

)

(2,819,862

)

(2,580,507

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(1,005,386

)

$

(1,457,690

)

$

(1,517,771

)

$

(2,929,255

)

 

 

 

 

 

 

 

 

 

 

Loss per common share, basic

 

$

(0.26

)

$

(0.20

)

$

(1.39

)

$

(0.40

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic

 

4,653,852

 

7,367,895

 

5,961,102

 

7,366,807

 

 

See notes to condensed consolidated financial statements.

 

2



Table of Contents

 

GRANITE CITY FOOD & BREWERY LTD.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

 

Thirty-nine Weeks Ended

 

 

 

September 27,

 

September 28,

 

 

 

2011

 

2010

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(1,517,771

)

$

(2,929,255

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

4,473,883

 

4,349,460

 

Amortization of deferred gain

 

(22,887

)

(135,959

)

Other amortization

 

52,363

 

120,067

 

Stock warrant/option expense

 

676,075

 

473,786

 

Non-cash interest (income) expense

 

(150,466

)

19,786

 

(Gain) loss on disposal of assets

 

(11,732

)

77,773

 

(Gain) loss on exit or disposal activities

 

(247,177

)

180,807

 

Deferred rent

 

(960,037

)

769,783

 

Changes in operating assets and liabilities:

 

 

 

 

 

Inventory

 

(95,230

)

(112,894

)

Prepaids and other

 

(137,306

)

133,545

 

Accounts payable

 

(89,971

)

92,877

 

Accrued expenses

 

(1,603,708

)

(1,356,866

)

Net cash provided by operating activities

 

366,036

 

1,682,910

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of:

 

 

 

 

 

Property and equipment

 

(4,419,115

)

(445,424

)

Intangible and other assets

 

(342,858

)

(52,364

)

Net cash used in investing activities

 

(4,761,973

)

(497,788

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from line of credit

 

1,000,000

 

 

Payments on capital lease obligations

 

(1,017,331

)

(514,135

)

Payments on long-term debt

 

(1,367,799

)

(353,282

)

Proceeds from long-term debt

 

5,000,000

 

 

Deferred transaction costs

 

301,425

 

 

Proceeds from issuance of preferred stock

 

9,000,000

 

 

Proceeds from issuance of common stock

 

101,321

 

 

Payments to repurchase common stock

 

(7,050,000

)

 

Net costs related to issuance of stock

 

(3,240,666

)

(111,740

)

Net cash provided by (used in) financing activities

 

2,726,950

 

(979,157

)

 

 

 

 

 

 

Net (decrease) increase in cash

 

(1,668,987

)

205,965

 

Cash and cash equivalents, beginning

 

3,104,320

 

1,743,599

 

Cash and cash equivalents, ending

 

$

1,435,333

 

$

1,949,564

 

 

 

 

 

 

 

Supplemental disclosure of non-cash investing and financing activities:

 

 

 

 

 

Long-term debt incurred upon execution of lease termination agreements

 

$

1,405,158

 

$

 

Non-cash stock option compensation included in deferred transaction costs

 

$

193,081

 

$

 

Property and equipment, intangibles and deferred transaction costs included in accounts payable and accrued expenses

 

$

444,434

 

$

141,688

 

Long-term debt and accrued interest extinguished upon the issuance of stock, net of issuance costs

 

$

641,453

 

$

 

 

See notes to condensed consolidated financial statements.

 

3



Table of Contents

 

GRANITE CITY FOOD & BREWERY LTD.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Thirteen and Thirty-nine weeks ended September 27, 2011 and September 28, 2010

 

1.     Summary of significant accounting policies

 

Background

 

Granite City Food & Brewery Ltd. (the “Company”) develops and operates Modern American casual dining restaurants known as Granite City Food & Brewery®.   The restaurant theme is upscale casual dining with a wide variety of menu items that are prepared fresh daily, combined with freshly brewed hand-crafted beers finished on-site.  The Company opened its first Granite City restaurant in St. Cloud, Minnesota in July 1999 and has since expanded to other Midwest markets.  As of September 27, 2011, the Company operated 26 restaurants in 11 states.  The Company also operates a centralized beer production facility which is used to provide raw material brewing support to its restaurants to create consistent quality and operational efficiencies in the production of its custom proprietary beers.  The Company believes that this brewing process improves the economics of microbrewing as it eliminates the initial stages of brewing and storage at multiple locations.  In 2007, the Company was granted a patent by the United States Patent Office for its brewing process and in June 2010, was granted an additional patent for an apparatus for distributed production of beer.

 

Principles of consolidation and basis of presentation

 

In May 2011, the Company completed its previously announced transaction with Concept Development Partners LLC (“CDP”) whereby it issued $9.0 million of newly issued Series A Convertible Preferred Stock (“Series A Preferred”) to CDP, entered into a $10.0 million credit agreement with Fifth Third Bank providing for senior credit facilities, repurchased 3,000,000 shares of common stock from DHW Leasing, L.L.C. (“DHW”) for approximately $7.1 million, and purchased real property in Troy, Michigan from an affiliate of DHW for approximately $2.6 million.  The CDP transaction has improved the Company’s capital position and provides financing for strategic growth by allowing the Company to build new restaurants in select markets, gain revenue by adding space through physical enhancements at key existing restaurant locations and improve operation efficiencies through upgraded technology.

 

The Company’s condensed consolidated financial statements include the accounts and operations of the Company and its subsidiary corporation under which its four Kansas locations are operated.  By Kansas state law, 50% of the stock of the subsidiary corporation must be owned by a resident of Kansas.  Granite City Restaurant Operations, Inc., a wholly-owned subsidiary of the Company, owns the remaining 50% of the stock of the subsidiary corporation.  The resident-owner of the stock of that entity has entered into a buy-sell agreement with the subsidiary corporation providing, among other things, that transfer of the shares is restricted and that the shareholder must sell his shares to the subsidiary corporation upon certain events, or any event that disqualifies the resident-owner from owning the shares under applicable laws and regulations of the state.  The Company has entered into a master agreement with the subsidiary corporation that permits the operation of the restaurants and leases to the subsidiary corporation the Company’s property and facilities.  The subsidiary corporation pays all of its operating expenses and obligations, and the Company retains, as consideration for the operating arrangements and the lease of property and facilities, all the net profits, as defined, if any, from such operations.  The foregoing ownership structure was set up to comply with the licensing and ownership regulations related to microbreweries within the state of Kansas.  The Company has determined that such ownership structure will cause the subsidiary corporation to be treated as a variable interest entity in which the Company has a controlling financial interest for the purpose of Financial Accounting Standards Board’s (“FASB”) accounting guidance on accounting for variable interest entities.  As such, the subsidiary corporation is consolidated with the Company’s financial statements and the Company’s financial statements do not reflect a minority ownership in the subsidiary corporation.  Also included in the Company’s condensed consolidated financial statements are other wholly-owned subsidiaries.  All references

 

4



Table of Contents

 

to the Company in these notes to the condensed consolidated financial statements relate to the consolidated entity, and all intercompany balances have been eliminated.

 

In the opinion of management, all adjustments, consisting of normal recurring adjustments, which are necessary for a fair statement of the Company’s financial position as of September 27, 2011, and its results of operations for the interim periods ended September 27, 2011 and September 28, 2010, have been included.

 

The balance sheet at December 28, 2010 has been derived from the audited financial statements at that date, but does not include all of the information and notes required by generally accepted accounting principles for complete financial statements.  Certain information and note disclosures normally included in the Company’s annual financial statements have been condensed or omitted.  These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 28, 2010, filed with the Securities and Exchange Commission (“SEC”) on February 28, 2011.

 

The results of operations for the thirteen and thirty-nine weeks ended September 27, 2011 are not necessarily indicative of the results to be expected for the entire year.

 

Related parties

 

In May 2011, CDP became the Company’s controlling shareholder through its purchase of Series A Preferred and a related shareholder and voting agreement with DHW.  As of November 7, 2011, CDP beneficially owned approximately 72.4% of the Company’s common stock, representing 6,000,000 shares issuable upon conversion of 3,000,000 shares of Series A Preferred owned by CDP, 1,666,666 shares over which CDP has voting power pursuant to a shareholder and voting agreement and irrevocable proxy between CDP and DHW, and 49,429 shares of common stock issued to CDP as dividend shares.

 

Use of estimates

 

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America and regulations of the SEC requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period.  Significant estimates include estimates related to asset lives and gift card liability.  Actual results could differ from these estimates.

 

Revenue recognition

 

Revenue is derived from the sale of prepared food and beverage and select retail items.  Revenue is recognized at the time of sale and is reported on the Company’s condensed consolidated statements of operations net of sales taxes collected.  Revenue derived from gift card sales is recognized at the time the gift card is redeemed.  Until the redemption of gift cards occurs, the outstanding balances on such cards are included in accrued expenses in the accompanying condensed consolidated balance sheets.  When the Company determines there is no legal obligation to remit the value of unredeemed gift cards to the relevant jurisdictions, the Company periodically recognizes gift card breakage which represents the portion of its gift card obligation for which management believes the likelihood of redemption by the customer is remote, based upon historical redemption patterns.  Such amounts are included as a reduction to general and administrative expense.

 

Cash and cash equivalents

 

The Company considers all highly liquid instruments with original maturities of three months or less to be cash equivalents.  Amounts receivable from credit card processors are considered cash equivalents because they are both short-term and highly liquid in nature and are typically converted to cash within three days of the sales transaction.

 

5



Table of Contents

 

Stock-based compensation

 

The Company measures and recognizes all stock-based compensation under the fair value method using the Black-Scholes option-pricing model. Share-based compensation expense recognized is based on awards ultimately expected to vest, and as such, it is reduced for estimated or actual forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company used the following assumptions within the Black-Scholes option-pricing model for the thirty-nine weeks ended September 27, 2011 and September 28, 2010:

 

 

 

Thirty-nine Weeks Ended

 

 

 

September 27, 2011

 

September 28, 2010

 

Weighted average risk-free interest rate

 

1.87% - 3.65%

 

2.58% - 3.89%

 

Expected life of options

 

5-10 years

 

10 years

 

Expected stock volatility

 

93.08% - 95.05%

 

94.27% - 95.86%

 

Expected dividend yield

 

None

 

None

 

 

Net loss per share

 

Basic net loss per share is calculated by dividing net loss less the sum of preferred stock dividends declared and the deemed-dividend from the beneficial conversion feature recorded, by the weighted average number of common shares outstanding during the period.  The beneficial conversion feature recorded pursuant to FASB Accounting Standards Codification Topic 470-20 resulted from the issuance of convertible preferred stock with a conversion price less than the fair value of the as converted common shares.  The beneficial conversion feature is the difference between the conversion price of the preferred stock and the fair value of the common stock into which the preferred stock is convertible (as calculated under the Black-Scholes pricing model), multiplied by the number of shares into which the preferred stock is convertible.  The result has no impact on the Company’s cash, net loss or total shareholders’ equity.  However, it does increase the net loss per common share for the purpose of presenting earnings per share.

 

Diluted net loss per share is not presented since the effect would be anti-dilutive due to the losses in the respective fiscal periods.  Calculations of the Company’s net loss per common share for the thirteen and thirty-nine weeks ended September 27, 2011 and September 28, 2010 are set forth in the following table:

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

September 27,
2011

 

September 28,
2010

 

September 27,
2011

 

September 28,
2010

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(1,005,386

)

$

(1,457,690

)

$

(1,517,771

)

$

(2,929,255

)

Less dividends declared

 

(202,500

)

 

(319,500

)

 

Less beneficial conversion feature

 

 

 

(6,459,758

)

 

Net loss available to common shareholders

 

$

(1,207,886

)

$

(1,457,690

)

$

(8,297,029

)

$

(2,929,255

)

 

 

 

 

 

 

 

 

 

 

Loss per common share, basic

 

$

(0.26

)

$

(0.20

)

$

(1.39

)

$

(0.40

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic

 

4,653,852

 

7,367,895

 

5,961,102

 

7,366,807

 

 

Of the net loss per common share, $(1.08) was attributable to the beneficial conversion feature in the thirty-nine weeks ended September 27, 2011.

 

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Table of Contents

 

2.     Fair value of financial instruments

 

At September 27, 2011 and December 28, 2010, the fair value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximates their carrying value due to the short-term nature of these financial instruments. The fair value of the capital lease obligations and long-term debt is estimated at its carrying value based upon current rates available to the Company.

 

3.              Significant transactions

 

In May 2011, the Company completed a preferred stock financing transaction with CDP, by issuing 3,000,000 shares of Series A Preferred to CDP for $9.0 million pursuant to a stock purchase agreement.  CDP acquired control of the Company through its purchase of the newly issued preferred stock and a related shareholder and voting agreement with DHW.  On the same date, the Company completed its previously announced common stock repurchase from DHW by repurchasing 3,000,000 shares of common stock for approximately $7.1 million pursuant to a stock repurchase agreement.  Contemporaneous with these transactions, the Company entered into a $10.0 million credit agreement with Fifth Third Bank providing for a secured term loan in the amount of $5.0 million, which was advanced in a single borrowing on the date of closing, and a secured line of credit agreement in the amount of $5.0 million, of which $3.5 million has been advanced as of November 7, 2011.  The line of credit loan and the term loan agreements mature on May 9, 2014.  Also on that same date in May 2011, the Company purchased an approximately two-acre site in Troy, Michigan, together with all plans, permits and related assets associated with the property, from Dunham Capital Management, L.L.C. (“DCM”), an affiliate of DHW, for approximately $2.6 million pursuant to a real estate purchase agreement.

 

4.              Restaurant closing and asset impairment charges

 

Rogers, Arkansas

 

In August 2008, the Company ceased operations at its Rogers, Arkansas restaurant, which failed to generate positive cash flow since opening in October 2007.  In the first quarter of fiscal year 2011, the Company entered into lease termination agreements regarding this property.  The lease termination agreement with the mall owner required the Company to pay $159,075 in cash and $400,000 payable under a five-year promissory note with an annual interest rate of 6.0%.  In order to offset the property development costs incurred by DCM, the Company entered into a lease termination agreement whereby it is required to pay DCM $1.0 million under a 20-year promissory note with an annual interest rate of 5.0%.  Pursuant to such agreements, the Company will incur no further costs associated with the property and has relinquished all equipment at the site.  The Company has written off all remaining assets, deferred rents and the sublease liability related to the Rogers property.  As such, in the first quarter of 2011, the Company recorded a reduction of assets of approximately $545,000, a reduction of liabilities of approximately $713,000 and a gain of approximately $168,000.  As of September 27, 2011, the Company’s total payments remaining under the terms of the lease termination agreements, including interest, were approximately $1.9 million.

 

Troy, Michigan

 

In May 2008, the Company entered into a 20-year net lease agreement relating to the restaurant it had planned to open in Troy, Michigan.  However, in February 2009, the Company decided not to build on that site, and as part of an agreement with DHW, DCM, Dunham Equity Management, L.L.C. (“DEM”) and other entities affiliated with Donald A. Dunham, Jr. (the “Dunham landlords”), which was amended in January 2011, the Company agreed to reimburse DCM for any out-of-pocket expenses incurred, including the carrying cost of the related land, less net proceeds from the sale of the real estate or lease income associated with the site.  In May 2011, the Company purchased the approximately two-acre site, together with all plans, permits and related assets associated with the property in “As Is” condition, from DCM for the sum of approximately $2.6 million.  Such sum included all closing costs of the real estate transaction and the previously unpaid carrying cost of approximately $740,100 which it had accrued and included in “accrued exit or disposal activities” on its balance sheet.  The Company intends to open a restaurant on this site in the first quarter of 2012.

 

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In the third quarter of 2011, $17,660 of interest expense related to the Rogers lease termination agreements was recorded on the Company’s condensed consolidated statements of operations as “exit or disposal activities.”   The following is a reconciliation of the beginning and ending balances of exit or disposal activities:

 

Accrued exit or disposal costs at December 28, 2010

 

$

2,333,218

 

 

 

 

 

Costs incurred and charged to expense

 

64,627

 

Payments

 

(830,377

)

Amortization of sublease liability

 

(222,527

)

Write off of sublease liability

 

(1,344,941

)

Accrued exit or disposal costs at September 27, 2011

 

$

 

 

5.              Non-current assets

 

Property and equipment

 

Property and equipment is recorded at cost and depreciated over the estimated useful lives of the assets.  Leasehold improvements are depreciated over the term of the related lease or the estimated useful life, whichever is shorter.  Depreciation and amortization of assets held under capital leases and leasehold improvements are computed on the straight-line method for financial reporting purposes.  The following is a summary of the Company’s property and equipment at September 27, 2011 and December 28, 2010:

 

 

 

September 27, 2011

 

December 28, 2010

 

 

 

 

 

 

 

Land

 

$

1,889,631

 

$

18,000

 

Buildings

 

34,901,162

 

35,357,007

 

Leasehold improvements

 

10,128,255

 

9,720,091

 

Equipment and furniture

 

33,242,089

 

33,740,408

 

Construction in progress *

 

1,242,693

 

92,151

 

 

 

81,403,830

 

78,927,657

 

Less accumulated depreciation

 

(32,289,147

)

(28,774,481

)

 

 

$

49,114,683

 

$

50,153,176

 

 


*Construction in progress includes the following approximate amounts for items yet to be placed in service:

 

 

 

September 27, 2011

 

December 28, 2010

 

Leasehold improvements for future locations

 

$

430,000

 

$

92,000

 

Leasehold improvements for current locations

 

$

440,000

 

 

Equipment and furniture for current locations

 

$

372,000

 

 

 

Intangible and other assets

 

Intangible and other assets consisted of the following:

 

 

 

September 27, 2011

 

December 28, 2010

 

Intangible assets:

 

 

 

 

 

Liquor licenses

 

$

768,115

 

$

760,865

 

Trademarks

 

217,902

 

196,064

 

Other:

 

 

 

 

 

Deferred loan costs

 

323,191

 

380,646

 

Security deposits

 

217,896

 

224,846

 

 

 

1,527,104

 

1,562,421

 

Less accumulated amortization

 

(106,541

)

(423,811

)

 

 

$

1,420,563

 

$

1,138,610

 

 

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6.        Accrued expenses

 

Accrued expenses consisted of the following:

 

 

 

September 27, 2011

 

December 28, 2010

 

Payroll and related

 

$

1,340,123

 

$

1,867,657

 

Deferred revenue from gift card sales

 

1,786,171

 

2,843,396

 

Sales taxes payable

 

521,927

 

540,837

 

Interest

 

331,875

 

352,208

 

Real estate taxes

 

502,285

 

526,260

 

Deferred registration costs

 

157,360

 

157,360

 

Credit card fees

 

99,295

 

159,092

 

Utilities

 

171,869

 

170,169

 

Other

 

273,589

 

167,563

 

 

 

$

5,184,494

 

$

6,784,542

 

 

7.  Deferred rent

 

Under the terms of the lease agreement the Company entered into regarding its Lincoln, Nebraska property, the Company received a lease incentive of $450,000, net.  This lease incentive was recorded as deferred rent and is being amortized to reduce rent expense over the initial term of the lease using the straight-line method.

 

Also included in deferred rent is the difference between minimum rent payments and straight-line rent over the initial lease term including the “build out” or “rent-holiday” period.  Deferred rent also includes amounts certain of the Company’s landlords agreed to defer for specified periods of time.  The deferrals are offset in part by the fair value of the warrants issued to certain landlords in consideration of rent reductions.  Contingent rent expense, which is based on a percentage of revenue, is also recorded to the extent it exceeds minimum base rent per the lease agreement.  As of September 27, 2011 and December 28, 2010, deferred rent payable consisted of the following:

 

 

 

September 27, 2011

 

December 28, 2010

 

Difference between minimum rent and straight-line rent

 

$

3,949,260

 

$

3,988,753

 

Warrant fair value

 

(215,187

)

(134,615

)

Deferred lease payments

 

29,164

 

1,378,831

 

Contingent rent expected to exceed minimum rent

 

111,935

 

41,641

 

Tenant improvement allowance

 

246,389

 

268,889

 

 

 

$

4,121,561

 

$

5,543,499

 

 

8.  Long-term debt

 

In May 2011, the Company paid the balance remaining on its long-term loan outstanding with First National Bank (“FNB”), an independent financial institution in Pierre, South Dakota, the proceeds of which the Company used to purchase assets at its Fargo, North Dakota restaurant.  Such payment was made with the proceeds of the

 

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Company’s sale of 3,000,000 shares of convertible preferred stock to CDP.  A second loan agreement with FNB, which was secured by the personal property and fixtures at the Company’s Davenport, Iowa restaurant, was paid in full in January 2011.

 

In August 2008, the Company issued a promissory note to an Indiana general partnership in the amount of $250,000.  The note was issued to secure the liquor license for the Company’s restaurant located in South Bend, Indiana.

 

In May 2011, approximately $641,500 of the Company’s indebtedness to Harmony Equity Income Fund, L.L.C. and Harmony Equity Income Fund II, L.L.C. (collectively, “Harmony”), was converted into 213,784 shares of the Company’s common stock at a conversion price of $3.00 per share.  Such issuance extinguished the remaining balance and accrued interest thereon of the bridge loan agreement dated March 30, 2009, as amended, with Harmony, a group of accredited investors of which Joel C. Longtin, a director of the Company, and Eugene E. McGowan, a former director of the Company, have beneficial interests.  At the time of its entry into the bridge loan agreement, the Company issued to Harmony warrants for the purchase of an aggregate of 53,332 shares of common stock at a price of $1.52 per share.

 

In December 2010, the Company entered into a lease termination agreement with the mall owner of its Rogers, Arkansas property.  Pursuant to this lease termination agreement, the Company issued a $400,000 five-year promissory note.

 

In March 2011, the Company entered into a lease termination agreement with DCM, the developer of its Rogers, Arkansas restaurant.  Pursuant to this lease termination agreement, the Company issued a $1.0 million 20-year promissory note.

 

In March 2011, the Company entered into a $1.3 million loan agreement with First Midwest Bank (“FMB”), an independent financial institution in Sioux Falls, South Dakota, for the purchase of the buildings and all related improvements associated with its Indianapolis and South Bend, Indiana restaurants.

 

In May 2011, the Company entered into a $10.0 million credit agreement with Fifth Third Bank, an Ohio banking corporation, secured by liens on the Company’s subsidiaries, personal property, fixtures and real estate owned or to be acquired.  The credit agreement provides for a secured term loan in the amount of $5.0 million, which was advanced in a single borrowing on May 10, 2011, and a secured line of credit agreement in the amount of $5.0 million, $3.5 million of which has been drawn down by the Company as of November 7, 2011.  Subject to the terms and conditions of the credit agreement, the bank has also agreed to issue standby letters of credit in an aggregate undrawn face amount up to $100,000, subject to reduction or modification.  The line of credit loan and the term loan agreements mature on May 9, 2014.  The term and credit line loans require the payment of interest at the Company’s option at (a) a fluctuating per annum rate equal to (i) a base rate plus 3.5% per annum or (ii) LIBOR plus 6.0% per annum, and (b) the term loan interest may also be paid at a fixed rate of 6.75%.  Interest is payable on either a monthly basis (with respect to base rate or fixed rate loans) or at the end of each 30, 60 or 90 day LIBOR period (with respect to LIBOR loans).  The Company pays a line of credit commitment fee equal to the difference between the total line of credit commitment and the amount outstanding under the line of credit, plus outstanding letters of credit, equal to either 0.50% of the unused line if the outstanding balance of the line is equal to or less than 50% of the total line of credit commitment, or 0.375% of the unused line of credit commitment (if the outstanding balance of the line of credit is greater than 50% of the total line of credit commitment).   The Company is obligated to make principal payments on the term loan in equal installments on the last day of March, June, September and December in each year commencing with the calendar quarter ending December 31, 2011, in the amount of $178,571 and a final payment of principal and interest on May 9, 2014.  Principal under the line of credit loan is paid in equal quarterly installments commencing on March 31, 2012 at a rate sufficient to amortize the principal balance of the line of credit loan over an 84-month period with a final payment of all principal and interest due on May 9, 2014. The amortization schedule on the line of credit loan will adjust on an annual basis at the end of each loan year.

 

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As of September 27, 2011 and December 28, 2010, the balances, interest rates and maturity dates of the Company’s long-term debt were as follows:

 

 

 

September 27,
2011

 

December 28, 2010

 

Davenport (FNB)

 

 

 

 

 

Balance

 

$

 

$

11,896

 

Annual interest rate

 

N/A

 

5.50

%

Maturity date

 

N/A

 

1/6/2011

 

 

 

 

 

 

 

Fargo (FNB)

 

 

 

 

 

Balance

 

$

 

$

1,129,883

 

Annual interest rate

 

N/A

 

8.75

%

Maturity date

 

N/A

 

8/15/2011

 

 

 

 

 

 

 

South Bend (Liquor license)

 

 

 

 

 

Balance

 

$

239,126

 

$

242,029

 

Annual interest rate

 

8.00

%

8.00

%

Maturity date

 

9/30/2023

 

9/30/2023

 

 

 

 

 

 

 

Harmony (Bridge loan)

 

 

 

 

 

Balance

 

$

 

$

748,479

 

Annual interest rate

 

N/A

 

9.00

%

Maturity date

 

N/A

 

12/1/2011

 

 

 

 

 

 

 

Rogers (GGP)

 

 

 

 

 

Balance

 

$

337,789

 

$

 

Annual interest rate

 

6.00

%

N/A

 

Maturity date

 

8/1/2015

 

N/A

 

 

 

 

 

 

 

Rogers (DCM)

 

 

 

 

 

Balance

 

$

989,572

 

$

 

Annual interest rate

 

5.00

%

N/A

 

Maturity date

 

8/1/2030

 

N/A

 

 

 

 

 

 

 

South Bend/Indianapolis (FMB)

 

 

 

 

 

Balance

 

$

1,302,666

 

$

 

Annual interest rate

 

5.00

%

N/A

 

Maturity date

 

1/1/2018

 

N/A

 

 

 

 

 

 

 

Fifth Third Bank (Line of Credit)

 

 

 

 

 

Balance

 

$

1,000,000

 

$

 

Annual interest rate

 

10.00

%

N/A

 

Maturity date

 

5/9/2014

 

N/A

 

 

 

 

 

 

 

Fifth Third Bank (Loan)

 

 

 

 

 

Balance

 

$

5,000,000

 

$

 

Annual interest rate

 

6.75

%

N/A

 

Maturity date

 

5/9/2014

 

N/A

 

 

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Table of Contents

 

As of September 27, 2011, future maturities of long-term debt, exclusive of interest, were as follows:

 

Year ending:

 

 

 

2011

 

$

39,024

 

2012

 

978,535

 

2013

 

1,177,047

 

2014

 

4,353,253

 

2015

 

156,844

 

Thereafter

 

2,164,450

 

 

 

$

8,869,153

 

 

9.        Capital leases

 

As of September 27, 2011, the Company operated 21 restaurants under capital lease agreements, of which one expires in 2020, one in 2022, three in 2023, three in 2024, three in 2026, three in 2027 and seven in 2030, all with renewable options for additional periods.  Nineteen of these lease agreements originated with the Dunham landlords.  Under certain of the leases, the Company may be required to pay additional contingent rent based upon restaurant sales.  At the inception and the amendment date of each of these leases, the Company evaluated the fair value of the land and building separately pursuant to the FASB guidance on accounting for leases.  The land portion of these leases is classified as an operating lease while the building portion of these leases is classified as a capital lease because its present value was greater than 90% of the estimated fair value at the beginning or amendment date of the lease and/or the lease term represents 75% or more of the expected life of the property.

 

During the first quarter of 2011, the Company entered into rental abatement and amendment agreements concerning its restaurants in Toledo, Ohio and Ft. Wayne, Indiana.  Pursuant to the agreements, the rental amounts for each lease have been reduced through 2018 and the Company was required to pay $515,713 of the $822,616 in rents it withheld during negotiations in 2009 and 2010.  The changes in the terms of these amendments caused the classification of the leases to change from operating to capital (included above). Pursuant to the terms of the lease amendments, the Company recorded additional assets and liabilities of approximately $3.2 million in the aggregate.

 

During the first quarter of 2011, the Company entered into a long-term debt agreement related to the building and all related improvements associated with its Indianapolis and South Bend, Indiana restaurants.  While the Company retained approximately $1.3 million in assets collateralized by such debt, the Company removed approximately $3.4 million in capital lease assets and capital lease liabilities from its balance sheet.

 

During the second quarter of 2011, the Company entered into lease amendments for eight of its restaurant leases.  Pursuant to the terms of such amendments, the Company reduced its assets and liabilities by approximately $1.6 million each in the aggregate.

 

The Company also has a land and building lease agreement for its beer production facility.  This ten-year lease allows the Company to purchase the facility at any time for $1.00 plus the unamortized construction costs.  Because the construction costs will be fully amortized through payment of rent during the base term, if the option is exercised at or after the end of the initial ten-year period, the option price will be $1.00.  As such, the lease, including land, is classified as a capital lease.

 

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Table of Contents

 

In May 2011, the Company used $369,470 of proceeds from the sale of Series A Preferred to CDP to retire the balance remaining on the equipment lease agreement with Carlton Financial Corporation concerning three of its restaurants.  The value of the equipment financed at the inception of the lease was approximately $3.3 million and the annual interest rate ranged from 12.9% to 19.6%.

 

In May 2011, the Company paid approximately $8,500 to retire the lease agreement for an energy optimization system at its Maple Grove, Minnesota restaurant. At the inception of the lease, the value of the leased equipment was approximately $30,000.

 

Included in property and equipment as of September 27, 2011 and December 28, 2010 are the following assets held under capital leases:

 

 

 

September 27, 2011

 

December 28, 2010

 

Land

 

$

18,000

 

$

18,000

 

Building

 

33,587,643

 

35,357,007

 

Equipment and leasehold improvements

 

 

3,365,588

 

 

 

33,605,643

 

38,740,595

 

Less accumulated depreciation

 

(9,325,129

)

(9,578,404

)

 

 

$

24,280,514

 

$

29,162,191

 

 

Minimum future lease payments under all capital leases as of September 27, 2011 were as follows:

 

Year ending:

 

Capital Leases

 

2011

 

$

1,010,689

 

2012

 

4,090,565

 

2013

 

4,174,742

 

2014

 

4,218,210

 

2015

 

4,144,116

 

Thereafter

 

49,214,649

 

Total minimum lease payments

 

66,852,971

 

Less amount representing interest

 

(36,086,992

)

Present value of net minimum lease payments

 

30,765,979

 

Less current portion

 

(706,920

)

Long-term portion of obligations

 

$

30,059,059

 

 

Amortization expense related to the assets held under capital leases is included with depreciation expense on the Company’s statements of operations.

 

10.      Commitments and contingencies

 

Litigation

 

From time to time, lawsuits are threatened or filed against the Company in the ordinary course of business.  Such lawsuits typically involve claims from customers, former or current employees, and others related to issues common to the restaurant industry.  A number of such claims may exist at any given time.  Although there can be no assurance as to the ultimate disposition of these matters, it is management’s opinion, based upon the information available as of November 7, 2011, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operation, liquidity or financial condition of the Company.

 

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Table of Contents

 

Employment agreements

 

On May 11, 2011, the Company entered into employment agreements with Robert J. Doran, its chief executive officer, and Dean S. Oakey, its chief concept officer.  Each agreement provides for employment with the Company through December 31, 2012, to be extended for additional one-year terms upon the mutual agreement of the Company and the executive.  Each executive is entitled to severance benefits including one year of base compensation if his employment is terminated without cause or for good reason, including upon a change in control, in addition to the balance of the executive’s compensation for the remainder of the term.  The agreements provide for an annual base salary, which may be increased by the Company’s board of directors, eligibility for an annual bonus of up to 50% of base salary based on achieving performance targets determined by the Company’s compensation committee, participation in the Company’s other employee benefit plans and expense reimbursement.  Each executive has also agreed to certain nondisclosure provisions during the term of his employment and any time thereafter, and certain non-competition and non-recruitment provisions during the term of his employment and for a certain period thereafter.  The annual base salaries for such executives have been set as follows: Mr. Doran ($355,000) and Mr. Oakey ($300,000).

 

On May 10, 2011, the Company entered into an amended and restated employment agreement with Steven J. Wagenheim.  This amended and restated agreement serves to address Mr. Wagenheim’s new position as president and founder of the Company.  The amendment also provides that the consummation of the CDP transaction does not constitute a “change in control” under his employment agreement.

 

Mr. Wagenheim, James G. Gilbertson, the Company’s chief financial officer, and Darius H. Gilanfar, its chief operating officer, have agreements with the Company that provide for their employment on an at-will basis. Each agreement, as amended, provides that the executive will have employment through October 6, 2012.  Each executive will be entitled to severance benefits that include one year of base compensation if his employment is terminated without cause or for good reason, as defined therein, in addition to the balance of the applicable term, if terminated prior to the end of such term.  Each employment agreement is automatically extended for a one-year term unless either the Company or the executive gives at least 60 days’ notice to the other of an intent not to extend. If the Company elects not to extend the executive’s employment beyond October 6, 2012, or beyond the end of any applicable extension, and terminates the executive’s employment, such termination will be deemed to be a termination without cause for purposes of severance benefits and the continuation of base compensation through the end of the applicable term.  The agreements also provide for a base annual salary which may be increased by the Company’s board of directors, incentive compensation as determined by the Company’s compensation committee from time to time, and participation in the Company’s other employee benefit plans. In addition, each agreement includes change in control provisions that entitle the executive to receive severance pay equal to 12 months of salary if there is a change in control of the Company and his employment is involuntarily terminated for any reason other than for cause, as defined in the agreement, or death or disability.  Each executive has also agreed to certain nondisclosure provisions during the term of his employment and any time thereafter, and certain non-competition, non-recruitment and/or non-interference provisions during the term of his employment and for a certain period thereafter. As of November 7, 2011, the current annual base salaries in effect for such executives under the foregoing employment agreements were as follows: Mr. Wagenheim ($300,000), Mr. Gilbertson ($225,000), and Mr. Gilanfar ($202,860).

 

Related party guarantees

 

One of the Company’s directors and one former director personally guaranteed certain of the Company’s leases and loan agreements.  The Company’s board of directors agreed to compensate Steven J. Wagenheim, the Company’s president, founder and one of its directors, for his personal guaranties of equipment loans entered into in August 2003, January 2004 and August 2006.  As of May 10, 2011, each of such loans had been paid in full and no additional compensation expense related to such loans will accrue.  During the first three quarters of fiscal years 2011 and 2010, the Company recorded $6,495 and $25,454 of such compensation in general and administrative expense, respectively, and paid $100 and $112,451 of such compensation, respectively.

 

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Table of Contents

 

Development agreement

 

In April 2008, the Company entered into a development agreement with United Properties Investment LLC (“United Properties”) for the development of up to 22 restaurants to be built between 2009 and 2012.  United Properties will be responsible for all costs related to the land and building of each restaurant.  The development agreement provides for a cooperative process between United Properties and the Company’s management for the selection of restaurant sites and the development of restaurants on those sites and scheduling for the development and construction of each restaurant once a location is approved.  The annual lease rate for fee-simple land and building developments will be 9.5% and the Company will have the right of first offer to purchase these restaurants.  Additionally, in the event United Properties sells one of the buildings that it develops for the Company at an amount in excess of the threshold agreed to by the parties in the agreement, then the Company will share in the profits of that sale.  The Company assumes no liability in the event United Properties sells a building at a loss.  The Company is not bound to authorize the construction of restaurants during that time period, but generally cannot use another developer to develop or own a restaurant as long as the development agreement is in effect.  The Company can, however, use another developer if United Properties declines to build a particular restaurant.  The Company currently has no sites under development pursuant to this agreement.

 

Purchase commitments

 

The Company has entered into contracts through 2016 with certain suppliers of raw materials (primarily hops) for minimum purchases both in terms of quantity and in pricing.   As of September 27, 2011, the Company’s future obligations under such contracts aggregated approximately $1.6 million.

 

11.       Stock option plans

 

On June 18, 2011, the remaining options to purchase 7,500 shares of common stock that were outstanding under the 1997 Director Stock Option Plan expired unexercised.  For service in 2011, each non-employee director was awarded a stock option for the purchase of 3,000 shares of common stock, exercisable for a period of ten years, under the Amended and Restated Equity Incentive Plan.

 

In August 2002, the Company adopted the 2002 Equity Incentive Plan, now known as the Amended and Restated Equity Incentive Plan, pursuant to which employees, prospective employees, officers and members of the Company’s board of directors, as well as consultants and advisors to the Company, may receive various types of awards including options to purchase shares of the Company’s common stock at an exercise price that equals or exceeds the fair market value on the date of grant.  The number of shares authorized for issuance as of September 27, 2011 was 1,275,000.  As of September 27, 2011, there were options outstanding under the plan for the purchase of 1,168,342 shares.  Although vesting schedules vary, option grants under this plan generally vest over a three or four-year period and options are exercisable for no more than ten years from the date of grant.

 

In May 2011, the Company’s shareholders approved a one-time stock option exchange program for employees under its Amended and Restated Equity Incentive Plan.  Under such program, which was completed on June 23, 2011, outstanding options held by employees for the purchase of 188,696 shares of common stock with exercise prices in excess of $6.00 per share were voluntarily exchanged by such holders for new options for the purchase of the same number of shares of common stock at an exercise price of $2.00 per share.  The new options will vest in full on December 28, 2011, one year following the date of approval of the option exchange program by the Company’s board of directors.

 

A summary of the status of the Company’s stock options as of September 27, 2011 is presented below:

 

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Table of Contents

 

Fixed Options

 

Shares

 

Weighted
Average
Exercise Price

 

Weighted
Average
Remaining
Contractual
Life

 

Aggregate
Intrinsic Value

 

Outstanding at December 29, 2009

 

394,019

 

$

16.07

 

6.6 years

 

$

78,467

 

 

 

 

 

 

 

 

 

 

 

Granted

 

823,496

 

2.15

 

9.6 years

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited

 

(96,126

)

12.14

 

 

 

 

 

Outstanding at December 28, 2010

 

1,121,389

 

$

6.19

 

8.5 years

 

$

68,433

 

 

 

 

 

 

 

 

 

 

 

Granted

 

155,500

 

3.54

 

8.3 years

 

 

 

Issued upon exchange

 

188,696

 

2.00

 

4.3 years

 

 

 

Forfeited upon exchange

 

(188,696

)

23.15

 

 

 

 

 

Exercised

 

(20,843

)

2.12

 

 

 

 

 

Forfeited

 

(84,371

)

8.80

 

 

 

 

 

Outstanding at September 27, 2011

 

1,171,675

 

$

2.31

 

7.9 years

 

$

166,513

 

 

 

 

 

 

 

 

 

 

 

Options exercisable at December 28, 2010

 

364,109

 

$

13.87

 

6.7 years

 

$

19,833

 

Options exercisable at September 27, 2011

 

387,346

 

$

2.52

 

8.1 years

 

$

51,566

 

 

 

 

 

 

 

 

 

 

 

Weighted-average fair value of options granted during 2011

 

$

3.08

 

 

 

 

 

 

 

 

The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing price of the Company’s stock on September 27, 2011 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 27, 2011.  As of September 27, 2011, there was approximately $721,447 of total unrecognized compensation cost related to unvested share-based compensation arrangements, of which $203,946 is expected to be recognized during the remainder of fiscal year 2011, $354,659 in fiscal year 2012, $128,514 in fiscal year 2013, $30,724 in fiscal year 2014 and $3,604 in fiscal year 2015.

 

The following table summarizes information about stock options outstanding at September 27, 2011:

 

 

 

Options Outstanding

 

Options Exercisable

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

Number of

 

Average

 

Weighted

 

Number of

 

Weighted

 

Range of 

 

Options

 

Remaining

 

Average

 

Options

 

Average

 

Exercise Prices 

 

Outstanding

 

Contractual Life

 

Exercise Price

 

Exercisable

 

Exercise Price

 

 

 

 

 

 

 

 

 

 

 

 

 

$1.00 - $6.00

 

1,167,509

 

7.9 years

 

$

2.27

 

383,555

 

$

2.40

 

$6.01 - $12.00

 

 

 

$

 

 

$

 

$12.01 - $18.00

 

4,166

 

2.5 years

 

$

14.21

 

3,791

 

$

14.40

 

Total

 

1,171,675

 

7.9 years

 

$

2.31

 

387,346

 

$

2.52

 

 

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12.  Common stock warrants

 

During the first eight months of 2009, in consideration of rent reduction agreements entered into with certain of its landlords, the Company issued five-year warrants to purchase the Company’s common stock to such landlords.  Pursuant to the anti-dilution provisions of such agreements, the number of shares purchasable under these warrants came to be 201,125 and the weighted average exercise price came to be $1.60 per share.  As of September 27, 2011, warrants for the purchase of 37,309 shares with exercise prices ranging from $1.58 to $3.00 per share had been exercised and warrants for the purchase of 163,816 shares remained unexercised.

 

Pursuant to the Harmony bridge loan agreement entered into in March 2009, the Company issued to the investors five-year warrants for the purchase of an aggregate of 53,332 shares of common stock at a price of $1.52 per share.  Such warrants became exercisable September 30, 2009, and remained unexercised at September 27, 2011.

 

In the second quarter of 2011, the Company entered into lease amendments with certain of its landlords.  In consideration of more favorable lease terms and conditions, the Company issued five-year warrants to purchase the Company’s common stock to such landlords.  The number of shares purchasable under these warrants is 40,000 and the exercise price is $3.32 per share.

 

As of September 27, 2011, warrants for the purchase of an aggregate of 257,148 shares of common stock were outstanding and exercisable.  The weighted average exercise price of such warrants was $1.85 per share.

 

13.       Equity

 

In May 2011, the Company completed a preferred stock financing transaction with CDP, in which it issued 3,000,000 shares of Series A Preferred to CDP for $9.0 million pursuant to a stock purchase agreement.  CDP acquired control of the Company through its purchase of the newly issued preferred stock and a related shareholder and voting agreement with DHW.  On the same date, the Company completed its previously announced common stock repurchase from DHW by repurchasing 3,000,000 shares of common stock for approximately $7.1 million pursuant to a stock repurchase agreement.

 

The Series A Preferred the Company issued to CDP has preference over the common stock in the event of an involuntary or voluntary liquidation or dissolution of the Company.  The Company is obligated to pay 9% dividends on the Series A Preferred through 2013, one-half of which is in the form of common stock.  Prior to conversion, the holder of Series A Preferred is entitled to 0.77922 votes per preferred share on all matters submitted to our shareholders, subject to proportionate adjustment upon adjustment to the conversion price under the certificate of designation upon a stock split or reverse stock split.  Finally, each share of Series A Preferred is convertible into two shares of the Company’s common stock at the holder’s option prior to December 31, 2014, and is automatically convertible on the first business day on or after December 31, 2014, on which the average closing sale prices of our common stock for the trading days within the 90 calendar day period ending on the date prior to the automatic conversion date is greater than $4.00 per share.

 

Pursuant to the terms of the Series A Preferred, on June 30, 2011, the Company paid $58,500 in cash dividends and issued 15,914 shares of its common stock to the preferred shareholder of record on that date.  On September 30, 2011, the Company paid $101,250 in cash dividends and issued 33,515 shares of its common stock to the preferred shareholder of record on that date.  Such amount was reflected in the liabilities and equity section of the Company’s balance sheet at September 27, 2011.

 

14.       Retirement plan

 

The Company sponsors a defined contribution plan under the provisions of section 401(k) of the Internal Revenue Code.  The plan is voluntary and is provided to all employees who meet the eligibility requirements.  A participant can elect to contribute up to 100% of his/her compensation subject to IRS limits.  Beginning in fiscal year 2009, the Company elected to match 10% of such contributions up to 6% of the participant’s compensation.

 

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In the first three quarters of 2011 and 2010, the Company contributed $11,093 and $10,485 in the aggregate, respectively, under the plan.

 

15.       Subsequent events

 

Long-term incentive plan

 

In October 2011, the Company’s shareholders approved its Long-Term Incentive Plan. The plan provides for flexible, broad-based incentive compensation in the form of stock-based awards of options, stock appreciation rights, warrants, restricted stock awards and restricted stock units, stock bonuses, cash bonuses, performance awards, dividend equivalents, and other equity-based awards. The issuance of up to 400,000 shares of common stock is authorized under the plan. All stock options issued under the plan must have an exercise price equal to or greater than the fair market value of the Company’s common stock on the date of grant. In addition, the plan prohibits the repricing of stock options without the approval of the Company’s shareholders.

 

Purchase and sale agreement

 

In October 2011, the Company entered into a purchase and sale agreement with Store Capital Acquisitions, LLC (“Store Capital”) regarding the restaurant under construction in Troy, Michigan.  Pursuant to the agreement, Store Capital will purchase the property and improvements for the lesser of $3.6 million or the actual costs the Company incurs for the property and construction of the restaurant thereon.  Upon the closing of the sale, the Company will enter into an agreement with Store Capital whereby the Company will lease the restaurant from Store Capital for an initial term of 15 years at an annual rental rate equal to the purchase price multiplied by a capitalization rate equal to the greater of 9.25% or 5.85% plus the 15-year swap rate.  Such agreement will include options for additional terms and provisions for rental adjustments.

 

Asset purchase agreement

 

In November 2011, the Company entered into a master asset purchase agreement to buy the assets of seven restaurants currently operated under the name “Cadillac Ranch All American Bar & Grill” (“Cadillac Ranch”).  Pursuant to the agreement, the Company closed on the purchase of the assets of one of the restaurants, CR Minneapolis, LLC (“CRM”), which operates as a Cadillac Ranch All American Restaurant Bar & Grill in the Mall of America in Bloomington, Minnesota, in November 2011.  The purchase price for these assets was $1.4 million, subject to adjustments, including a reduction if the purchase of the remaining assets is not consummated through no fault of the Company’s.  The Company has assumed CRM’s lease at the Mall of America for the restaurant with certain modifications.  The Company also has an option to buy the assets of an eighth restaurant for nominal consideration and assumption of the related lease.

 

The aggregate purchase price for the assets of Cadillac Ranch is $9.0 million, subject to adjustment including, but not limited to, an increase of $200,000 for post-acquisition consulting services.  Additional debt or equity financing will be required to consummate the balance of the asset purchases.  The remaining obligations of the parties are subject to various customary closing conditions.  If conditions with respect to a restaurant are not met, those assets may be excluded from the purchase and the purchase price reduced as agreed.  The parties contemplate that the remaining assets will be purchased during the fourth quarter of 2011 if the conditions are met.  The Company’s obligations to purchase the remaining assets is subject to conditions including, but not limited to, obtaining required consent from its principal lender, obtaining satisfactory financing, completion of due diligence and approval by its board of directors.

 

ITEM 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This discussion and analysis contains various non-historical forward-looking statements within the meaning of Section 21E of the Exchange Act.  Although we believe that, in making any such statement, our expectations are based on reasonable assumptions, any such statement may be influenced by factors that could cause actual outcomes and results to be materially different from those projected.  When used in the following discussion, the words “anticipates,” “believes,” “expects,” “intends,” “plans,” “estimates” and similar expressions, as they relate to us or our management, are intended to identify such forward-looking statements.  You are

 

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cautioned not to attribute undue certainty to such forward-looking statements, which are qualified in their entirety by the cautions and risks described herein.  Please refer to our Cautionary Statement contained within our Current Report on Form 8-K filed with the Securities and Exchange Commission on May 17, 2011 for additional factors known to us that may cause actual results to vary.

 

Overview

 

We are a Modern American upscale casual restaurant chain.   As of September 27, 2011, we operated 26 restaurants in 11 Midwestern states featuring on-premises breweries, substantially all of which operate under the name of Granite City Food & Brewery®.  We believe our menu features high quality yet affordable family favorite menu items prepared from made-from-scratch recipes and served in generous portions.  We believe that the sophisticated yet unpretentious restaurants, proprietary food and beverage products, attractive price points and high service standards combine for a great dining experience.

 

We operate a centrally-located beer production facility in Ellsworth, Iowa which facilitates the initial stage of our patented brewing process.  We believe that this brewing process improves the economics of microbrewing as it eliminates the initial stages of brewing and storage at multiple locations, thereby reducing equipment and development costs at new restaurant locations.  Additionally, having a common starting point, the beer production creates consistency of taste for our product from restaurant to restaurant.  The initial product produced at our beer production facility is transported by truck to the fermentation vessels at each of our restaurants where the brewing process is completed. In May 2007, we were granted a patent by the United States Patent and Trademark Office for this proprietary beer brewing process.  This patent covers the method and apparatus for maintaining a centralized facility for the production of unfermented and unprocessed hopped wort (one of the last steps of the beer brewing production process) which is then transported to our restaurant fermentation tanks where it is finished into beer.  In October 2008, we were granted a federally registered trademark for Fermentus Interruptus. In June 2010, we were granted an additional patent for an apparatus for distributed production of beer.  We believe that our current beer production facility, which opened in June 2005, has the capacity to service 35 to 40 restaurant locations.

 

In May 2011, we completed our previously announced transaction with Concept Development Partners LLC (“CDP”) whereby we issued $9.0 million of newly issued Series A Convertible Preferred Stock (“Series A Preferred”) to CDP, entered into a $10.0 million credit agreement with the Fifth Third Bank providing for senior credit facilities, repurchased 3,000,000 shares of common stock from DHW Leasing, L.L.C. (“DHW”) for approximately $7.1 million, and purchased real property in Troy, Michigan from an affiliate of DHW for approximately $2.6 million.  The CDP transaction has improved our capital position and provides financing for strategic growth by allowing us to build new restaurants in select markets, gain revenue by adding space at key existing restaurant locations and improve operation efficiencies through upgraded technology.

 

Through its purchase of the newly issued Series A Preferred and a related shareholder and voting agreement with DHW, CDP acquired control of our company.  As of November 7, 2011, CDP beneficially owned approximately 72.4% of our common stock, representing 6,000,000 shares issuable upon conversion of 3,000,000 shares of Series A Preferred owned by CDP, 1,666,666 shares over which CDP has voting power pursuant to a shareholder and voting agreement and irrevocable proxy between CDP and DHW, and 49,429 shares of common stock issued to CDP as dividend shares.

 

Our industry can be significantly affected by changes in economic conditions, discretionary spending patterns, consumer tastes, and cost fluctuations.  In recent years, consumers have been under increased economic pressures and as a result, many have changed their discretionary spending patterns.  Many consumers are dining out less frequently than in the past and/or have decreased the amount they spend on meals while dining out.  To offset the negative impact of decreased sales, we undertook a series of initiatives to renegotiate the pricing of various aspects of our business, effectively reducing our cost of food, insurance, payroll processing, shipping, supplies and our property and equipment rent.  We have implemented marketing initiatives designed to increase brand awareness and help drive guest traffic.  We believe these initiatives contributed to the increase in sales and

 

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Table of Contents

 

guest traffic in fiscal year 2010 over that of 2009, as well as the increase in both sales and guest traffic in the first three quarters of 2011 over the first three quarters of 2010.

 

We believe that our operating results will fluctuate significantly because of several factors, including the operating results of our restaurants, changes in food and labor costs, increases or decreases in comparable restaurant sales, general economic conditions, consumer confidence in the economy, changes in consumer preferences, nutritional concerns and discretionary spending patterns, competitive factors, the skill and the experience of our restaurant-level management teams, the maturity of each restaurant, adverse weather conditions in our markets, and the timing of any future restaurant openings and related expenses.

 

We utilize a 52/53-week fiscal year ending the last Tuesday in December for financial reporting purposes.  The third quarters of 2011 and 2010 each included 338 operating weeks, which is the sum of the actual number of weeks each restaurant operated.  The first three quarters of 2011 and 2010 each included 1,014 operating weeks.  Because we have opened new restaurants at various times throughout the years, we provide this statistical measure to enhance the comparison of revenues from period to period as changes occur in the number of units we are operating.

 

Our restaurant revenue is comprised almost entirely of the sales of food and beverages.  The sale of retail items typically represents less than one percent of total revenue.  Product costs include the costs of food, beverages and retail items.  Labor costs include direct hourly and management wages, taxes and benefits for restaurant employees.  Direct and occupancy costs include restaurant supplies, marketing costs, rent, utilities, real estate taxes, repairs and maintenance and other related costs.  Pre-opening costs consist of direct costs related to hiring and training the initial restaurant workforce, the salaries and related costs of our new store opening team, rent expense incurred during the construction period and other direct costs associated with opening new restaurants.  General and administrative expenses are comprised of expenses associated with all corporate and administrative functions that support existing operations, which include management and staff salaries, employee benefits, travel, information systems, training, market research, professional fees, supplies and corporate rent.  Depreciation and amortization includes depreciation on capital expenditures at the restaurant and corporate levels and amortization of intangibles that do not have indefinite lives.  Interest expense represents the cost of interest expense on debt and capital leases net of interest income on invested assets.

 

Results of operations as a percentage of sales

 

The following table sets forth results of our operations expressed as a percentage of sales for the thirteen and thirty-nine weeks ended September 27, 2011 and September 28, 2010:

 

 

 

Thirteen Weeks Ended

 

Thirty-nine Weeks Ended

 

 

 

September 27,

 

September 28,

 

September 27,

 

September 28,

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Restaurant revenue

 

100.0

%

100.0

%

100.0

%

100.0

%

 

 

 

 

 

 

 

 

 

 

Cost of sales:

 

 

 

 

 

 

 

 

 

Food, beverage and retail

 

27.2

 

27.7

 

27.2

 

27.6

 

Labor

 

34.0

 

34.3

 

34.2

 

34.3

 

Direct restaurant operating

 

15.6

 

15.7

 

14.9

 

14.7

 

Occupancy

 

8.1

 

9.0

 

7.5

 

9.4

 

Total cost of sales

 

85.0

 

86.7

 

83.8

 

86.0

 

 

 

 

 

 

 

 

 

 

 

General and administrative

 

8.7

 

7.1

 

8.2

 

7.1

 

Depreciation and amortization

 

6.4

 

6.8

 

6.5

 

6.6

 

Exit or disposal activities

 

0.1

 

1.7

 

(0.2

)

0.9

 

Loss (gain) on disposal of assets

 

0.2

 

0.1

 

(0.0

)

(0.1

)

Operating income (loss)

 

(0.3

)

(2.4

)

1.9

 

(0.5

)

 

 

 

 

 

 

 

 

 

 

Interest:

 

 

 

 

 

 

 

 

 

Income

 

0.0

 

0.0

 

0.0

 

0.0

 

Expense

 

(4.1

)

(4.2

)

(4.0

)

(3.8

)

Net interest expense

 

(4.1

)

(4.2

)

(4.0

)

(3.8

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

(4.4

)%

(6.5

)%

(2.2

)%

(4.3

)%

 

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Table of Contents

 

Certain percentage amounts do not sum due to rounding.

 

Critical Accounting Policies

 

Our critical accounting policies are those that require significant judgment.  There have been no material changes to the critical accounting policies previously reported in our Annual Report on Form 10-K for the fiscal year ended December 28, 2010, filed with the Securities and Exchange Commission on February 28, 2011.

 

Results of operations for the thirteen and thirty-nine weeks ended September 27, 2011 and September 28, 2010

 

Revenue

 

We generated $22,945,303 and $22,271,547 of revenue during the third quarters of 2011 and 2010, respectively.  The 3.0% increase in the third quarter of 2011 revenue was primarily the result of an increase in guest traffic of approximately 2.2% as well as a slight menu price increase at the end of fiscal year 2010.  Average weekly revenue per restaurant increased $1,994 from $65,892 in the third quarter of 2010 to $67,886 in the third quarter of 2011.

 

During the first three quarters of 2011 we generated $70,072,350 of revenue compared to $67,729,980 in the first three quarters of 2010.  The 3.5% increase in the first three quarters of 2011 revenue was primarily the result of an increase in guest traffic of approximately 3.1% as well as a slight menu price increase at the end of fiscal year 2010.  Average weekly revenue per restaurant increased $2,310 from $66,795 in the first three quarters of 2010 to $69,105 in the first three quarters of 2011.

 

We expect that restaurant revenue will vary from quarter to quarter.  Continued seasonal fluctuations in restaurant revenue are due in part to increased outdoor seating and weather conditions.  Due to the honeymoon effect that periodically occurs with the opening of a restaurant, we expect the timing of any future restaurant openings to cause fluctuations in restaurant revenue.  Additionally, other factors outside of our control, such as timing of holidays, consumer confidence in the economy and changes in consumer preferences may affect our future revenue.

 

Restaurant costs

 

Food and beverage

 

Our food and beverage costs, as a percentage of revenue, decreased 0.5% to 27.2% in the third quarter of 2011 from 27.7% in the third quarter of 2010.  Such costs decreased 0.4% as a percentage of revenue to 27.2% in the first three quarters of 2011 from 27.6% in the first three quarters of 2010.  While we experienced slight cost increases, primarily in wine, bottled beer, protein and dairy, such increases were more than offset by decreases in

 

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Table of Contents

 

tap beer, soft drink, chicken, produce and liquor costs.  While pricing negotiations with our suppliers have reduced our exposure to commodity price increases, we do expect that our food and beverage costs will continue to vary going forward due to numerous variables, including seasonal changes in food and beverage costs for certain products for which we do not have contracted pricing, fluctuations within commodity-priced goods and guest preferences.  We periodically create new menu offerings and introduce new craft brewed beers based upon guest preferences.  Although such menu modifications may temporarily result in increased food and beverage cost, we believe we are able to offset such increases with our weekly specials which provide variety and value to our guests.  Our varieties of craft brewed beer, which we believe we can produce at a lower cost than beers we purchase for resale, also enable us to keep our food and beverage costs low while fulfilling guest requests and building customer loyalty.

 

Labor

 

Labor expense consists of restaurant management salaries, hourly staff payroll costs, other payroll-related items including management bonuses, and non-cash stock-based compensation expense.  Our experience to date has been that staff labor costs associated with a newly opened restaurant, for approximately its first four to six months of operation, are greater than what can be expected after that time, both in aggregate dollars and as a percentage of revenue.

 

Our labor costs, as a percentage of revenue, decreased 0.3% to 34.0% in the third quarter of 2011 from 34.3% in the third quarter of 2010.  Such costs decreased 0.1% as a percentage of revenue to 34.2% in the first three quarters of 2011 from 34.3% in the first three quarters of 2010.  While we experienced a slight increase in our employee benefits, our total labor expense decreased as a percent of revenue for the first three quarters of 2011.  Non-cash stock-based compensation was $200,726 in the first three quarters of 2011 compared to $198,126 in the first three quarters of 2010.

 

We expect that labor costs will vary as minimum wage laws, local labor laws and practices, and unemployment rates vary from state to state, as will hiring and training expenses.  We believe that retaining good employees and more experienced staff ensures high quality guest service and may reduce hiring and training costs.

 

Direct restaurant operating

 

Operating supplies, repairs and maintenance, utilities, promotions and restaurant-level administrative expense represent the majority of our direct restaurant operating expense, a portion of which is fixed or indirectly variable.  Our direct restaurant operating expense, as a percentage of revenue, decreased 0.1% to 15.6% in the third quarter of 2011 from 15.7% in the third quarter of 2010.  Such costs increased 0.2% as a percentage of revenue to 14.9% in the first three quarters of 2011 from 14.7% in the first three quarters of 2010.  While we experienced decreases in utilities, printing and small wares, we had increases in paper and plastic, marketing and maintenance and repair costs.

 

We continue to seek ways to reduce our direct operating costs going forward including additional pricing negotiations with suppliers and the elimination of waste.

 

Occupancy

 

Our occupancy costs, which include both fixed and variable portions of rent, common area maintenance charges, property insurance and property taxes, decreased 0.9% as a percentage of revenue to 8.1% in the third quarter of 2011 from 9.0% in the third quarter of 2010.  Such costs decreased 1.9% as a percentage of revenue to 7.5% in the first three quarters of 2011 from 9.4% in the first three quarters of 2010.  Our occupancy cost decreased due to the conversion of many of our leases from operating leases to capital leases.  As capital leases, a portion of the lease expense is recorded as interest expense and reduction of liability.  As operating leases, all lease expense is recorded as an occupancy cost included in rent expense.  During the second half of 2010 and early 2011, lease amendments we entered into with the Dunham landlords caused the classification of six leases to

 

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Table of Contents

 

change from operating leases to capital leases.  As a result, we expect our rent expense to remain lower and our interest expense to remain higher than such expenses were in 2010.  Additionally, in the second quarter of 2011, we entered into lease amendments which reduced the monthly payments for eight of our restaurant properties.

 

In the first quarter of 2011, we entered into rental abatement agreements for our restaurants in Toledo, Ohio and Ft. Wayne, Indiana.  Pursuant to the agreements, we were required to pay $515,713 of the $822,616 in rents we had recorded as expense and withheld during negotiations in 2009 and 2010.  As such, we wrote off the remaining deferred rents of approximately $307,000 to occupancy.

 

Also included in our rent expense is the difference between our current rent payments and straight-line rent expense over the initial lease term.  This non-cash rent expense of $116,674 and $640,446 is included in occupancy costs in the first three quarters of 2011 and 2010, respectively.  The $528,772 decrease in non-cash rent expense was due primarily to the changes in lease terms and conditions pursuant to lease amendments.

 

General and administrative

 

General and administrative expense includes all salaries and benefits, including non-cash stock-based compensation, associated with our corporate staff that is responsible for overall restaurant quality, any future expansion into new locations, financial controls and reporting, restaurant management recruiting, management training, and excess capacity costs related to our beer production facility.  Other general and administrative expense includes advertising, professional fees, investor relations, office administration, centralized accounting system costs and travel by our corporate management.

 

General and administrative expense increased $397,144 to $1,985,543 in the third quarter of 2011 from $1,588,399 in the third quarter of 2010.  Such expenses increased $933,150 to $5,736,591 in the first three quarters of 2011 from $4,803,441 in the first three quarters of 2010.  Of this year-to-date increase, $199,690 was non-cash stock-based compensation for employees and non-employee board members.  As a percentage of revenue, general and administrative expenses increased 1.6% in the third quarter of 2011 and 1.1% in the first three quarters of 2011 over the respective periods in 2010.  The primary sources of such increases were expenses related to employee compensation, consulting and recruiting, office technology and travel.

 

As we seek new ways to build revenue, we will continue to closely monitor our general and administrative costs and attempt to reduce these expenses as percent of revenue while preserving an infrastructure that remains suitable for our current operations.  Although we may need to recruit additional personnel to provide continued oversight of operations, we expect our turnover ratios to return to levels more consistent with the industry, allowing us to better manage our employee costs.  To the extent our turnover increases above our expectations, additional costs above our budgeted figures could be incurred in our recruiting and training expenses.

 

Depreciation and amortization

 

Depreciation and amortization expense decreased $53,963 to $1,458,486 in the third quarter of 2011 from $1,512,449 in the third quarter of 2010.  Such expense increased $56,719 in the first three quarters of 2011 compared to the same period of 2010.  As a percentage of revenue, depreciation expense decreased 0.1% to 6.5% in the first three quarters of 2011 from 6.6% in the first three quarters of 2010.  We anticipate depreciation expense will increase as we complete enhancements at selected restaurants including increased seating in the bars, enclosure of patios for year-round service, and the addition of private dining rooms to accommodate private parties and reduce wait times in peak periods.

 

Exit or disposal activities

 

In August 2008, we closed our Rogers, Arkansas restaurant, which failed to generate positive cash flow since opening in October 2007.  In the first quarter of 2011, we entered into lease termination agreements regarding this property.  The lease termination agreement with the mall owner required us to pay $159,075 in cash and $400,000 payable under a five-year promissory note with an annual interest rate of 6.0%.  In order to offset

 

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Table of Contents

 

the property development costs incurred by DCM, we entered into a lease termination agreement whereby we are required to pay DCM $1.0 million under a 20-year promissory note with an annual interest rate of 5.0%. Interest payments related to these termination agreements will be recorded as exit and disposal activities.  Pursuant to such agreements, we will incur no further costs associated with the property and have relinquished all equipment at the site.  We have written off all remaining assets, deferred rents and the sublease liability related to the Rogers property.  As such, in the first quarter of 2011, we recorded a reduction of assets of approximately $545,000, a reduction of liabilities of approximately $713,000 and income of approximately $168,000.  As of September 27, 2011, our total payments remaining under the terms of the lease termination agreements, including interest, were approximately $1.9 million.

 

In May 2008, we entered into a 20-year net lease agreement relating to the restaurant we had planned to open in Troy, Michigan.  However, in February 2009, we decided not to build on that site, and as part of an agreement with the Dunham landlords, which was amended in January 2011, we agreed to reimburse DCM for any out-of-pocket expenses incurred, including the carrying cost of the related land, less net proceeds from the sale of the real estate or lease income associated with the site.  In May 2011, we purchased the approximately two-acre site, together with all plans, permits and related assets associated with the property in “As Is” condition, from DCM for the sum of approximately $2.6 million.  Such sum included all closing costs of the real estate transaction and the previously unpaid carrying cost of approximately $740,100, which we had accrued and included in “accrued exit or disposal activities” on our balance sheet.  We intend to open a restaurant on this site in the first quarter of 2012.

 

Interest

 

Net interest expense consists of interest expense on capital leases and long-term debt, net of interest earned from cash on hand.  Net interest expense increased $16,976 to $947,993 in the third quarter of 2011 from $931,017 in the third quarter of 2010.  Such expense increased $239,355 to $2,819,862 in the first three quarters of 2011 from $2,580,507 in the first three quarters of 2010.  This year-to-date increase was due to the reclassification of several of our leases from operating leases to capital leases.  As a result of such reclassifications, certain expense that was recorded as occupancy expense in 2010 was recorded as interest expense in the 2011.  We expect our interest expense related to our restaurant properties to be higher and our occupancy expense to be lower in 2011 compared to 2010 due to such lease reclassifications.

 

Liquidity and capital resources

 

As of September 27, 2011, we had $1,435,333 of cash and a working capital deficit of $6,481,128 compared to $3,104,320 of cash and a working capital deficit of $9,197,110 at December 28, 2010.  As of September 27, 2011, we had additional cash availability of $4.0 million under our secured line of credit facility with Fifth Third Bank.

 

During the thirty-nine weeks ended September 27, 2011, we obtained $2,726,950 of net cash through financing activities.  Such funds were made up of $9.0 million in cash proceeds from the sale of our Series A Preferred, the receipt of $6.0 million in proceeds from a credit facility with Fifth Third Bank and $101,320 of cash from the exercise of options and warrants, offset in part by payments we made on our debt and capital lease obligations aggregating $2,385,129, $7,050,000 of cash used to repurchase 3,000,000 shares of our common stock from DHW and $2,939,241 of cash for costs associated with the CDP transaction.  We obtained $366,036 of net cash in operating activities and used $4,761,973 of cash for debt issuance costs and to purchase property and equipment.

 

During the thirty-nine weeks ended September 28, 2010, we generated $1,682,910 of net cash from operating activities.  We used $497,788 of cash to purchase equipment and other assets and made payments aggregating $867,417 on our debt and capital lease obligations.  We used $114,223 of cash related to the issuance of common stock to DHW and made cash payments aggregating $175 to shareholders in lieu of receiving fractional shares related to our reverse stock split. We received $2,658 of cash upon the exercise of a landlord warrant.

 

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Stock Purchase Agreement and Stock Repurchase Agreement:

 

In May 2011, we completed our previously announced transaction with CDP whereby we issued 3,000,000 shares of Series A Preferred for $9.0 million, each share of which is convertible into two shares of our common stock, equivalent to a conversion price of $1.50 per share.  Such preferred stock has preference over the common stock in the event of an involuntary or voluntary liquidation or dissolution of our company.  We are obligated to pay 9% dividends on the preferred stock through 2013, one-half of which is in the form of common stock.  Prior to conversion, the holder of Series A Preferred is entitled to 0.77922 votes per preferred share on all matters submitted to our shareholders, subject to proportionate adjustment upon adjustment to the conversion price under the certificate of designation upon a stock split or reverse stock split.  Finally, each share of Series A Preferred is convertible into two shares of our common stock at the holder’s option prior to December 31, 2014, and is automatically convertible on the first business day on or after December 31, 2014, on which the average closing sale prices of our common stock for the trading days within the 90 calendar day period ending on the date prior to the automatic conversion date is greater than $4.00 per share.

 

Through its purchase preferred stock and a related shareholder and voting agreement with DHW, CDP acquired control of our company.  As of November 7, 2011, CDP beneficially owned approximately 72.4% of our common stock, representing 6,000,000 shares issuable upon conversion of 3,000,000 shares of Series A Preferred owned by CDP, 1,666,666 shares over which CDP has voting power pursuant to a shareholder and voting agreement and irrevocable proxy between CDP and DHW, and 49,429 shares of common stock issued to CDP as dividend shares.

 

On the same day in May 2011, we completed our previously announced common stock repurchase from DHW by repurchasing 3,000,000 shares of common stock for approximately $7.1 million pursuant to a stock repurchase agreement.  Pursuant to separate agreements with DCM, we restructured six of our existing leases to provide significant rent reductions and for options to purchase certain restaurant lease interests.  Additionally, we purchased the approximately two-acre site in Troy, Michigan, together with all plans, permits and related assets associated with the property in “As Is” condition, from DCM for the sum of approximately $2.6 million.  Such sum included all closing costs of the real estate transaction and the previously unpaid carrying cost of approximately $740,100 which we had accrued and included in “accrued exit or disposal activities” on our balance sheet.  We intend to open a restaurant on this site in the first quarter of 2012.

 

Credit Facility:

 

In May 2011, we entered into a $10.0 million credit agreement with Fifth Third Bank, an Ohio banking corporation, secured by liens on our subsidiaries, personal property, fixtures and real estate owned or to be acquired.  The credit agreement provides for a secured term loan in the amount of $5.0 million, which was advanced in a single borrowing on May 10, 2011, and a secured line of credit agreement in the amount of $5.0 million, $3.5 million of which has been advanced to our company as of November 7, 2011.  Subject to the terms and conditions of the credit agreement, the bank has also agreed to issue standby letters of credit in an aggregate undrawn face amount up to $100,000, subject to reduction or modification.  The line of credit loan and the term loan agreements mature on May 9, 2014.  The term and credit line loans requires the payment of interest at our option at (a) a fluctuating per annum rate equal to (i) a base rate plus 3.5% per annum or (ii) LIBOR plus 6.0% per annum, and (b) the term loan interest may also be paid at a fixed rate of 6.75%.  Interest is payable on either a monthly basis (with respect to base rate or fixed rate loans) or at the end of each 30, 60 or 90 day LIBOR period (with respect to LIBOR loans).  We pay a line of credit commitment fee equal to the difference between the total line of credit commitment and the amount outstanding under the line of credit, plus outstanding letters of credit, equal to either 0.50% of the unused line if the outstanding balance of the line is equal to or less than 50% of the total line of credit commitment, or 0.375% of the unused line of credit commitment (if the outstanding balance of the line of credit is greater than 50% of the total line of credit commitment).   We are obligated to make principal payments on the term loan in equal installments on the last day of March, June, September and December in each year commencing with the calendar quarter ending December 31, 2011, in the amount of $178,571 and a final payment of principal and interest on May 9, 2014.  Principal under the line of credit loan is paid in equal quarterly installments commencing on March 31, 2012 at a rate sufficient to amortize the principal balance of the line of

 

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credit loan over an 84-month period with a final payment of all principal and interest due on May 9, 2014. The amortization schedule on the line of credit loan will adjust on an annual basis at the end of each loan year.

 

Funding Operations and Expansion:

 

During fiscal year 2010 and the first three quarters of 2011, we operated at a level that allowed us to fund our existing operations.  We believe this same level of sales and margins will allow us to fund our obligations for the foreseeable future.  We continue to evaluate strategies for growth under the assumption that we will continue to generate positive cash flow from existing operations.  Under such assumption and with the credit facility available to us, we are implementing a variety of initiatives both to generate new revenue and to invest in technologies to improve our existing business and financial condition.  Furthermore, we believe the opportunity exists to begin increasing our number of restaurants and thereby our future revenue and cash flow.  In addition, we believe such expansion will lessen turnover and related costs as we expect to be better able to retain managers and other key personnel who may otherwise seek new opportunities with other restaurant chains.

 

We expect to generate additional revenue through new store growth, primarily within our existing geographic footprint.  We recently received approval from the city of Troy, Michigan to construct a new Granite City restaurant on the property we own in Troy.  We expect to open such restaurant in the first quarter of 2012.  We are analyzing other potential new restaurant sites and expect to increase revenue through expansion.

 

We also seek to generate additional revenue through physical changes in some of our high volume restaurants including increased seating in the bars, enclosure of patios for year-round service, and the addition of private dining rooms to accommodate private parties, corporate events, and reduce wait times in peak periods.  We evaluate the costs of these potential capital enhancements relative to the projected revenue gains, thereby determining the expected return on investment of these potential store modifications.  We have identified five to eight existing restaurants where we believe the modifications would meet these criteria and intend to have such modifications completed at four locations in 2011.

 

We also believe we can improve the efficiency of our restaurants with table management systems and kitchen management systems designed to increase table turnover, provide a higher level of service to our customers, improve overall dining experience, increase our sales, and improve our financial condition.  We intend to have these systems fully implemented at five of our restaurants by year-end.

 

The above objectives assume that, in addition to continued access to the credit facility, we continue to generate positive cash flow.  If we cease generating positive cash flow, our business could be adversely affected and we may be required to alter or cease our plans for expansion, store modifications and technological improvements.  Our ability to continue funding our operations and meet our debt service obligations continues to depend upon our operating performance, and more broadly, achieving budgeted revenue and operating margins, both of which will be affected by prevailing economic conditions in the retail and casual dining industries and other factors, which may be beyond our control.  If revenue or margins, or a combination of both, decrease to levels unsustainable for continuing operations, we may require additional equity or debt financing to meet ongoing obligations.  The amount of any such required funding would depend upon our ability to generate working capital.

 

Commitments

 

Long-term debt:

 

In May 2011, we paid the balance remaining on our long-term loan outstanding with First National Bank, an independent financial institution in Pierre, South Dakota, the proceeds of which we used to purchase assets at our Fargo, North Dakota restaurant.  Such payment was made with the proceeds of our sale of 3,000,000 shares of convertible preferred stock to CDP.  A second loan from First National Bank, which was secured by the personal property and fixtures at our Davenport, Iowa restaurant, was paid in full in January 2011.

 

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As of September 27, 2011, the balance on our promissory note to an Indiana general partnership secured by the liquor license at our South Bend, Indiana restaurant was $239,126.  Such note matures in September 2023 and carries an annual interest rate of 8.0%.

 

In May 2011, approximately $641,500 of our indebtedness to Harmony Equity Income Fund, L.L.C. and Harmony Equity Income Fund II, L.L.C. (collectively, “Harmony”), was converted into 213,784 shares of our common stock at a conversion price of $3.00 per share.  Such issuance extinguished the remaining balance and accrued interest thereon of the bridge loan agreement dated March 30, 2009, as amended, with Harmony, a group of accredited investors of which Joel C. Longtin, one of our directors, and Eugene E. McGowan, one of our former directors, have beneficial interests.  At the time of our entry into the bridge loan agreement, we issued to Harmony warrants for the purchase of an aggregate of 53,332 shares of common stock at a price of $1.52 per share.

 

In December 2010, we entered into a lease termination agreement with the mall owner of our Rogers, Arkansas property.  Pursuant to this lease termination agreement, we issued a $400,000 five-year promissory note with an annual interest rate of 6.0%.  As of September 27, 2011, the balance of the promissory note was $337,789.

 

In March 2011, we entered into a lease termination agreement with DCM, the developer of our Rogers, Arkansas restaurant.  Pursuant to this lease termination agreement, we issued a $1.0 million 20-year promissory note with an annual interest rate of 5.0%.  As of September 27, 2011, the balance of the promissory note was $989,572.

 

In March 2011, we entered into a $1.3 million loan agreement with First Midwest Bank, an independent financial institution in Sioux Falls, South Dakota, for the purchase of the buildings and all related improvements associated with our Indianapolis and South Bend, Indiana restaurants.  The note requires us to pay interest at an annual rate of 5.0% and matures in January 2018.  The balance of such note at September 27, 2011 was $1,302,666.

 

Capital Leases:

 

Property leases

 

As of September 27, 2011, we operated 21 restaurants under capital lease agreements, of which one expires in 2020, one in 2022, three in 2023, three in 2024, three in 2026, three in 2027 and seven in 2030, all with renewable options for additional periods.  Nineteen of these lease agreements originated with the Dunham landlords.  Under certain of the leases, we may be required to pay additional contingent rent based upon restaurant sales.  At the inception and the amendment date of each of these leases, we evaluated the fair value of the land and building separately pursuant to the FASB guidance on accounting for leases.  The land portion of these leases is classified as an operating lease while the building portion of these leases is classified as a capital lease because its present value was greater than 90% of the estimated fair value at the beginning or amendment date of the lease and/or the lease term represents 75% or more of the expected life of the property.

 

In December 2004, we entered into a land and building lease agreement for our beer production facility.  This ten-year lease, which commenced February 1, 2005, allows us to purchase the facility at any time for $1.00 plus the unamortized construction costs.  Because the construction costs will be fully amortized through payment of rent during the base term, if the option is exercised at or after the end of the initial ten-year period, the option price will be $1.00.  As such, the lease is classified as a capital lease.

 

Equipment leases

 

In May 2011, we used $369,470 of proceeds from the sale of Series A Preferred to CDP to pay off in full the balance remaining on the equipment lease agreement with Carlton Financial Corporation concerning three of

 

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our restaurants.  The value of the equipment financed at the inception of the lease was approximately $3.3 million and the annual interest rate ranged from 12.9% to 19.6%.

 

In May 2011, we paid approximately $8,500 to pay off in full the lease agreement for an energy optimization system at our Maple Grove, Minnesota restaurant. At the inception of the lease, the value of the leased equipment was approximately $30,000.

 

Operating Lease:

 

The land portions of the 21 property leases referenced above, 19 lease agreements of which originated with the Dunham landlords, are classified as operating leases because the fair value of the land was 25% or more of the leased property at the inception of each lease.  All scheduled rent increases for the land during the initial term of each lease are recognized on a straight-line basis.  In addition to such property leases, we have obligations under the following operating leases:

 

In January 2001, we entered into a 20-year operating lease for the land upon which we built our Fargo, North Dakota restaurant.  Under the lease terms, we are obligated to annual rent of $72,000 plus contingent rent based upon restaurant sales.

 

We operate our restaurant in Eagan, Minnesota under an operating lease agreement with Dunham.  Such lease expires in 2018 and has renewable options for additional periods. Scheduled rent increases during the initial term are recognized on a straight-line basis.

 

In March 2006, we entered into a lease agreement for the land and building for our St. Louis Park, Minnesota restaurant.  Rental payments for this lease are $148,625 annually.  This operating lease expires in 2016 with renewal options for additional periods.

 

We lease the land upon which we operate our restaurant in South Bend and Indianapolis, Indiana.  Annual lease payments are $275,364 and $306,176, respectively, and such leases expire in 2028 and 2024, respectively.  Each lease has renewal options for additional periods.

 

In August 2005, we entered into a 38-month lease agreement for office space for our corporate offices.  The lease commenced October 1, 2005.  In November 2007 and again in December 2009, we entered into amendments to such lease to include additional space and rent reduction.  Pursuant to the amended lease, which expires in November 2011, annual rent is $92,665.  Scheduled rent increases have been recognized on a straight-line basis over the term of the lease.

 

Personal Guaranties:

 

Our board of directors agreed to compensate Steven J. Wagenheim, our, president, founder and one of our directors, for his personal guaranties of equipment loans entered into in August 2003, January 2004 and August 2006.  The amount of annual compensation for each of these guarantees was 3% of the balance of the obligation and was calculated and accrued based on the weighted average daily balance of the obligation at the end of each monthly accounting period.  As of May 10, 2011, each of such loans had been paid in full and no additional compensation expense related to such loans will accrue.  During the first half of fiscal years 2011 and 2010, we recorded $6,495 and $18,272 of such compensation in general and administrative expense, respectively, and paid $100 and $105,000 of such compensation, respectively.

 

Employment Agreements:

 

On May 11, 2011, we entered into employment agreements with Robert J. Doran, our chief executive officer, and Dean S. Oakey, our chief concept officer.  Each agreement provides for employment with our company through December 31, 2012, to be extended for additional one-year terms upon the mutual agreement of our company and the executive.  Each executive is entitled to severance benefits including one year of base

 

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compensation if his employment is terminated without cause or for good reason, including upon a change in control, in addition to the balance of the executive’s compensation for the remainder of the term.  The agreements provide for an annual base salary, which may be increased by our board of directors, eligibility for an annual bonus of up to 50% of base salary based on achieving performance targets determined by our compensation committee, participation in our company’s other employee benefit plans and expense reimbursement.  Each executive has also agreed to certain nondisclosure provisions during the term of his employment and any time thereafter, and certain non-competition and non-recruitment provisions during the term of his employment and for a certain period thereafter.  The annual base salaries for such executives have been set as follows: Mr. Doran ($355,000) and Mr. Oakey ($300,000).

 

On May 10, 2011, we entered into an amended and restated employment agreement with Steven J. Wagenheim.  This amended and restated agreement serves to address Mr. Wagenheim’s new position as president and founder of our company.  The amendment also provides that the consummation of the CDP transaction does not constitute a “change in control” under his employment agreement.

 

Mr. Wagenheim, James G. Gilbertson, our chief financial officer, and Darius H. Gilanfar, our chief operating officer, have agreements with our company providing for their employment on an at-will basis.  Each agreement, as amended, provides that the executive will have employment through October 6, 2012.  Each executive will be entitled to severance benefits that include one year of base compensation if his employment is terminated without cause or for good reason, as defined therein, in addition to the balance of the applicable term, if terminated prior to the end of such term.  Each employment agreement is automatically extended for a one-year term unless either our company or the executive gives at least 60 days’ notice to the other of an intent not to extend. If our company elects not to extend the executive’s employment beyond October 6, 2012, or beyond the end of any applicable extension, and terminates the executive’s employment, such termination will be deemed to be a termination without cause for purposes of severance benefits and the continuation of base compensation through the end of the applicable term.  The agreements also provide for a base annual salary which may be increased by our board of directors, incentive compensation as determined by our compensation committee from time to time, and participation in our company’s other employee benefit plans.  In addition, each agreement includes change in control provisions that entitle the executive to receive severance pay equal to 12 months of salary if there is a change in control of our company and his employment is involuntarily terminated for any reason other than for cause, as defined in the agreement, or death or disability.  Each executive has also agreed to certain nondisclosure provisions during the term of his employment and any time thereafter, and certain non-competition, non-recruitment and/or non-interference provisions during the term of his employment and for a certain period thereafter.  As of November 7, 2011, the current annual base salaries in effect for such executives under the foregoing employment agreements were as follows: Mr. Wagenheim ($300,000), Mr. Gilbertson ($225,000), and Mr. Gilanfar ($202,860).

 

Development Agreement:

 

In April 2008, we entered into a development agreement with United Properties for the development of up to 22 restaurants to be built between 2009 and 2012.  United Properties will be responsible for all costs related to the land and building of each restaurant.  The development agreement provides for a cooperative process between United Properties and our management for the selection of restaurant sites and the development of restaurants on those sites and scheduling for the development and construction of each restaurant once a location is approved.  The annual lease rate for fee-simple land and building developments will be 9.5% and we will have the right of first offer to purchase these restaurants.  Additionally, in the event United Properties sells one of the buildings that it develops for us at an amount in excess of the threshold agreed to by the parties in the agreement, then we will share in the profits of that sale.  We assume no liability in the event United Properties sells a building at a loss.  We are not bound to authorize the construction of restaurants during that time period, but generally cannot use another developer to develop or own a restaurant as long as the development agreement is in effect.  We can, however, use another developer if United Properties declines to build a particular restaurant.  We currently have no sites under development pursuant to this agreement.

 

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Off- balance sheet arrangements:

 

We have not entered into any off-balance sheet arrangements as it is not our business practice to do so.

 

Summary of contractual obligations:

 

The following table summarizes our obligations under contractual agreements and the timeframe within which payments on such obligations are due.  This table does not include amounts related to contingent rent as such future amounts are not determinable.  In addition, whether we would incur any additional expense on our employment agreements depends upon the existence of a change in control of our company coupled with a termination of employment or other unforeseeable events.  Therefore, neither contingent rent nor severance expense has been included in the following table.

 

 

 

Payment due by period

 

Contractual
Obligations

 

Total

 

Fiscal Year
2011

 

Fiscal Years
2012-2013

 

Fiscal Years
2014-2015

 

Fiscal Years
Thereafter

 

Long-term debt, principal

 

$

8,869,153

 

$

39,024

 

$

2,155,582

 

$

4,510,097

 

$

2,164,451

 

Interest on long-term debt

 

2,117,670

 

153,105

 

1,033,862

 

354,808

 

575,896

 

Capital lease obligations, including interest

 

66,852,971

 

1,010,689

 

8,265,307

 

8,362,326

 

49,214,649

 

Operating lease obligations, including interest

 

64,097,035

 

1,049,281

 

8,395,560

 

8,583,888

 

46,068,306

 

Purchase contracts*

 

1,628,525

 

160,611

 

1,060,688

 

190,416

 

216,810

 

Loan guarantee

 

21,191

 

21,191

 

 

 

 

Total obligations

 

$

143,586,547

 

$

2,433,901

 

$

20,910,999

 

$

22,001,535

 

$

98,240,112

 

 


*While we are contractually obligated to make these purchases, we have the contractual right to defer such purchases into later years.  However, if we defer such purchases into later years, we may incur additional charges.

 

Certain amounts do not sum due to rounding.

 

During fiscal year 2010 and the first three quarters of 2011, we operated at a level that allowed us to fund our existing operations.  We believe this same level of sales and margins will allow us to fund our obligations for the foreseeable future.  In connection with the sale of Series A Preferred to CDP, we have been to be able to lower our occupancy cost.  Although we expect to increase our number of restaurants through expansion, we believe that continued access to our credit facility and the cash generated from existing operations we will be sufficient to fund our current obligations.

 

Critical Accounting Estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires the appropriate application of certain accounting policies, which require us to make estimates and assumptions about future events and their impact on amounts reported in our financial statements and related notes. Since future events and their impact cannot be determined with certainty, the actual results will inevitably differ from our estimates.  Such differences could be material to the financial statements.

 

We believe the application of accounting policies, and the estimates inherently required therein, are reasonable. These accounting policies and estimates, including those related to inventory, long-lived assets, and revenue recognition, are reevaluated on an ongoing basis, and adjustments are made when facts and circumstances

 

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dictate a change. Historically, we have found our application of accounting policies to be appropriate, and actual results have not differed materially from those determined using necessary estimates.

 

Our critical accounting policies and estimates are discussed in and should be read in conjunction with our annual report on Form 10-K, as filed with the SEC on February 28, 2011, which includes audited consolidated financial statements for our 2010 and 2009 fiscal years. There have been no material changes to the critical accounting policies and estimates disclosed in the 2010 Form 10-K.

 

Recent Accounting Pronouncements

 

There are no new accounting pronouncements for which adoption is expected to have a material effect on our financial statements in future accounting periods.

 

Seasonality

 

We expect that our sales and earnings will fluctuate based on seasonal patterns.  We anticipate that our highest sales and earnings will occur in the second and third quarters due to the milder climate and availability of outdoor seating during those quarters in our markets.

 

Inflation

 

The primary inflationary factors affecting our operations are food, supplies and labor costs.  A large percentage of our restaurant personnel is paid at rates based on the applicable minimum wage, and increases in the minimum wage directly affect our labor costs.  In the past, we have been able to minimize the effect of these increases through menu price increases and other strategies.  To date, inflation has not had a material impact on our operating results.

 

Subsequent Events

 

Purchase and sale agreement:

 

In October 2011, we entered into a purchase and sale agreement with Store Capital Acquisitions, LLC (“Store Capital”) regarding our restaurant under construction in Troy, Michigan.  Pursuant to the agreement, Store Capital will purchase the property and improvements for the lesser of $3.6 million or the actual costs we incur for the property and construction of the restaurant thereon.  Upon the closing of the sale, we will enter into an agreement with Store Capital whereby we will lease the restaurant from Store Capital for an initial term of 15 years at an annual rental rate equal to the purchase price multiplied by a capitalization rate equal to the greater of 9.25% or 5.85% plus the 15-year swap rate.  Such agreement will include options for additional terms and provisions for rental adjustments.

 

Asset purchase agreement:

 

In November 2011, we entered into a master asset purchase agreement to buy the assets of seven restaurants currently operated under the name “Cadillac Ranch All American Bar & Grill” (“Cadillac Ranch”).  Pursuant to the agreement, we closed on the purchase of the assets of one of the restaurants, CR Minneapolis, LLC (“CRM”), which operates as a Cadillac Ranch All American Restaurant Bar & Grill in the Mall of America in Bloomington, Minnesota, in November 2011.  The purchase price for these assets was $1.4 million, subject to adjustments, including a reduction if the purchase of the remaining assets is not consummated through no fault of ours.  We have assumed CRM’s lease at the Mall of America for the restaurant with certain modifications.  We also have an option to buy the assets of an eighth restaurant for nominal consideration and assumption of the related lease

 

The aggregate purchase price for the assets of Cadillac Ranch is $9.0 million, subject to adjustment including, but not limited to, an increase of $200,000 for post-acquisition consulting services.  Additional debt or

 

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equity financing will be required to consummate the balance of the asset purchases.  The remaining obligations of the parties are subject to various customary closing conditions.  If conditions with respect to a restaurant are not met, those assets may be excluded from the purchase and the purchase price reduced as agreed.  The parties contemplate that the remaining assets will be purchased during the fourth quarter of 2011 if the conditions are met.  Our obligations to purchase the remaining assets is subject to conditions including, but not limited to, obtaining required consent from our principal lender, obtaining satisfactory financing, completion of due diligence and approval by our board of directors.

 

ITEM 3                   Quantitative and Qualitative Disclosures about Market Risk

 

Our company is exposed to market risk from changes in interest rates on debt and changes in commodity prices.

 

Changes in interest rates:

 

Pursuant to the terms of our long-term debt agreement with an independent financial institution, we will have a balloon payment due of approximately $3.2 million in May 2014.  If it becomes necessary to refinance such balloon balance, we may not be able to secure financing at the same interest rate.  The effect of a higher interest rate would depend upon the negotiated financing terms.

 

Changes in commodity prices:

 

Many of the food products and other commodities we use in our operations are subject to price volatility due to market supply and demand factors outside of our control.  Fluctuations in commodity prices and/or long-term changes could have an adverse effect on us.  These commodities are generally purchased based upon market prices established with vendors.  To manage this risk in part, we have entered into fixed price purchase commitments, with terms typically up to one year, for many of our commodity requirements.  We have entered into contracts through 2016 with certain suppliers of raw materials (primarily hops) for minimum purchases both in terms of quantity and pricing.   As of September 27, 2011, our future obligations under such contracts aggregated approximately $1.6 million.

 

Although a large national distributor is our primary supplier of food, substantially all of our food and supplies are available from several sources, which helps to control commodity price risks.  Additionally, we have the ability to increase menu prices, or vary the menu items offered, in response to food product price increases.  If, however, competitive circumstances limit our menu price flexibility, our margins could be negatively impacted.

 

Our company does not enter into derivative contracts either to hedge existing risks or for speculative purposes.

 

ITEM 4                   Controls and Procedures

 

Evaluation of disclosure controls and procedures

 

We maintain a system of disclosure controls and procedures that is designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of September 27, 2011, our disclosure controls and procedures were effective.

 

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Changes in internal control over financial reporting

 

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 27, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II                 OTHER INFORMATION

 

ITEM 1                   Legal Proceedings

 

From time to time, lawsuits are threatened or filed against us in the ordinary course of business.  Such lawsuits typically involve claims from customers, former or current employees, and others related to issues common to the restaurant industry.  A number of such claims may exist at any given time.  Although there can be no assurance as to the ultimate disposition of these matters, it is management’s opinion, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the results of operation, liquidity or financial condition of our company.

 

ITEM 1A                Risk Factors

 

There have been no material changes with respect to the risk factors set forth in the Cautionary Statement contained within our Current Report on Form 8-K, filed with the Securities and Exchange Commission on May 17, 2011.

 

ITEM 2                   Unregistered Sales of Equity Securities and Use of Proceeds

 

(a)           On June 30, 2011, we issued 15,914 shares of our common stock as dividend payment to the holders of our Series A Preferred as required by the terms and conditions of such securities.

 

The foregoing issuance was made in reliance upon the exemption provided in Section 4(2) of the Securities Act.  The certificate representing such securities contains a restrictive legend preventing sale, transfer or other disposition, absent registration or an applicable exemption from registration requirements.  The recipient of such securities received, or had access to, material information concerning our company, including, but not limited to, our reports on Form 10-K, Form 10-Q, and Form 8-K, as filed with the Securities and Exchange Commission.  No discount or commission was paid in connection with the issuance of such common stock.

 

ITEM 3                   Defaults upon Senior Securities

 

None.

 

ITEM 4                   (Removed and Reserved)

 

ITEM 5                   Other Information

 

None.

 

ITEM 6                   Exhibits

 

See “Index to Exhibits.”

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

GRANITE CITY FOOD & BREWERY LTD.

 

 

 

 

Date:

November 10, 2011

By:

/s/ James G. Gilbertson

 

James G. Gilbertson

 

Chief Financial Officer

 

(As Principal Financial Officer and Duly Authorized Officer of Granite City Food & Brewery Ltd.)

 

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INDEX TO EXHIBITS

 

Exhibit

 

 

Number

 

Description

 

 

 

3.1

 

Amended and Restated Articles of Incorporation of the Company including the Certificate of Designation for Series A Preferred Stock.

 

 

 

3.2

 

Amended and Restated Bylaws of the Company, dated May 2, 2007 (incorporated by reference to our Current Report on Form 8-K, filed on May 4, 2007 (File No. 000-29643)).

 

 

 

4.1

 

Reference is made to Exhibits 3.1 and 3.2.

 

 

 

4.2

 

Specimen common stock certificate (incorporated by reference to our Current Report on Form 8-K, filed on September 20, 2002 (File No. 000-29643)).

 

 

 

31.1